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Global Macro - New Normal Or The Big Turn?

Global Macroeconomic & Market Update / New Normal or the Big Turn?

The good news first: Global GDP continues to recover and is projected to be around 3.5% for 2013 and about 4.1% for 2014 according to the latest estimates. However, advanced economies continue to experience little to no economic growth which is going to have an impact on the job market in those countries. We believe that this is not going to improve much in the coming months and think it will take at least another 6-12 months before we are starting to see increased hiring activity. The recent U.S. Jobs Report for February, which showed a gain of 236'000 jobs (forecasted 165'000) came as a big surprise to many and the market reacted positively to the news. We feel that the jobs report needs to be put in the right context in order to see how good or bad things are. We have often argued that it is not so much about the headline numbers but much more about the quality of the jobs being created. Looking deeper, these numbers tell a different story. Since 2008, the U.S. lost about 8.9mln jobs and since the end of 2009 the economy only created 5.7mln new jobs. So if the job creation continues at the same speed, it will take another two years or so just to get back to the levels prior to the recession of 2008. What is even more disturbing is the fact that the jobs being created are not of the same quality as the jobs that were lost. Also, more and more people only work part time; while a changing lifestyle might explain some of that, most people simply can't find full time employment anymore. (We also need to mention here that in the meantime the preliminary job numbers for March came in much weaker than anticipated). The situation in other countries, for example Spain and Italy, is similar or even worse. Young people in particular are struggling to find jobs. This in turn is creating serious social economic problems. The worsening job situation will continue to force structural reforms intended to liberalize the job market which will hopefully change things to the better, but we can't see much of an improvement in the next 12-18 months.

While the outlook for developed countries remains weak, growth in emerging economies is accelerating with GDP in those regions growing by about 5.5% in 2013 and 5.9% next year. This is encouraging and we expect the improving growth momentum of emerging markets to have a positive impact on developed economies eventually. The improving business conditions in emerging economies are especially visible in the earnings numbers of large companies operating globally.

Global equity markets seem to already anticipate the improving outlook and have started to rise since the fourth quarter of last year. There are a number of reasons for the recent positive developments of equity markets. While the overall improving economic outlook is clearly helpful, the lack of investment alternatives has been another important reason for the surge of equity prices. In a world of record low interest rates, the bond markets are not a real alternative. Other investments such as precious metals have also become less attractive on a relative basis considering the steep outperformance in the last decade. With fair valuations, good dividend yields and the outlook for improving corporate profits, global equities are again a very attractive place for investors. The chart below shows the strong performance of global equity markets in recent months, with the chart on the right hand side showing the declining volatility of markets, another sign that some of the negative pressure is gone. So in short, there is a compelling combination of various factors that have driven equity markets in recent months and the outlook for the next 12-18 months doesn't seem to be very different.

Explaining the recent surge in equity markets is therefore relatively easy but for long-term investors the main question is whether this outperformance has a chance to continue for a longer period of time. We even ask the question: Could there be a structural bull market for equities coming? Considering the huge market challenges we had in recent years, this question seems a bit over ambitious. There are, however, some interesting points to think about. Historically, interest rates have followed a 30 year cycle from peak to trough. In this last cycle, interest rates peaked in the early 80's and have since then trended lower and since yields are now close to zero, it seems realistic that we are nearing another turning point. Stock market cycles are usually shorter than that of bond markets, typically 15 to 20 years. Stock markets have gone nowhere since the peak in 2000 so it also seems realistic to assume that this cycle seems to be in a mature state.

So is it possible that the recent surge in stock prices is the start of a longer-term bull market? Eventually central banks have to normalize monetary policies and there will be less cheap money flowing into markets. Many fear that once this starts to happen, equity prices are going to drop significantly. Again, looking at history, this concern doesn't seem justified. Actually, the opposite is true. Turning points in interest rate cycles have normally also been turning points for equity markets and rising yields do not cause a selloff in equities. This means that in coming years we could see the current spike in equity prices turn into a structural bull market for equities, even if central banks eventually start to hike rates.

Another indication that the pressure is easing - falling bond yields/increased refinancing

Higher interest rates are not always a bad sign for an economy and as long as the increase takes places over a certain period of time, higher rates are not necessarily triggering a selloff in equity prices. While interest rates remain low in many parts of the world, we believe that yields are slowly starting to turn around. Over a time frame of 12-18 months we see a continuing normalization of interest rates, higher economic activity and renewed growth momentum in corporate profits.

What are the risk factors that could bring back renewed, negative market volatility? A few come to mind, but we think that neither the European debt crisis nor the U.S. deficit story are changing things in a meaningful way. We are more concerned about geopolitical events such as the situation with North Korea or Iran. Especially close we are watching the situation with North Korea with great concern. While the recent actions by the North Korean regime have failed to impact markets negatively, the risk in our view is that a small event or accident could trigger military actions from North and/or South Korea. Such an event could further destabilize the region and cause enormous uncertainty among financial markets worldwide. For now, we still think this is a low probability event but it needs to be monitored very carefully.